CFC under the ATADUmsG

German tax law also takes into account the legal capacity of entities such as foreign corporations in international situations. This principle in the taxation of corporations is known as the separation principle.

The corporation thus shields the profits it generates from taxation at the level of its shareholders. This also applies to foreign corporations, whose profits are generally not taxed at the level of domestic shareholders until a distribution of profits occurs. Until then, the profit remains exempt from German taxation.

This circumstance has for a long time - and not only in Germany - caused taxpayers to consider setting up corporations in low-tax countries for purely tax motives. The German legislator reacted to this in 1972 as a consequence of the so-called tax haven report with the provisions on controlled foreign corporation rules in §§ 7 ff. AStG. The last significant changes to the Controlled Foreign Corporation Rules were made by the Act Implementing the Anti-Tax Avoidance Directive (ATADUmsG) in 2021, but the main features have remained unchanged since its introduction.

The controlled foreign corporation rules are intended to prevent persons liable to tax in Germany from taking advantage of the international tax differential by involving corporations that are not actively involved. However, due in particular to the (excessively) high low tax threshold (currently: 25%), more and more situations are subject to the controlled foreign corporation rules, which are increasingly becoming the norm for taxing cross-border situations.

The anachronism of the low tax threshold of 25% is also made clear by the global minimum tax (Global Anti-Base Erosion Rules) of 15%, which affects all companies with group sales of more than EUR 750 million that prepare a country-by-country report of multinational groups. The global minimum tax has been implemented by an EU directive at the end of 2022 and is expected to be applied for the first time in the EU for all fiscal years beginning after December 31, 2023. Accordingly, the legislator should - finally - lower the low tax threshold from 25% to 15%.

Sections 7 AStG et seq. prevent the exploitation of tax advantages through the involvement of non-active foreign corporations in low-tax countries by means of a "distribution fiction" (cf. Sections 7 (1) sentence 1 and 10 (2) sentence 1 AStG). Income of the foreign company that does not result from an active activity is subject to domestic taxation at a time independent of its actual distribution, without the (partial) tax exemptions otherwise provided for profit distributions (final withholding tax, partial income procedure or exemption from taxation) being applied.

The Controlled foreign corporation rules basically include the following factual requirements, namely.

• the existence of a foreign company,
• which is controlled by an unlimited or limited taxpayer and
• so-called interim income is generated.

Interim income is passive income of the foreign company within the meaning of Sec. 8 (1) AStG that is subject to taxation at a rate of less than 25% (Sec. 8 (5) AStG).

Persons subject to unlimited tax liability:

§ Section 7 (1) sentence 1 AStG requires an unlimited taxpayer. This includes income and corporate taxpayers. Unrestricted tax liability means unlimited tax liability of individuals on the basis of domestic residence or habitual abode (Sec. 1 (1) Sentence 1 EStG) and of corporate tax subjects such as corporations on the basis of domestic registered office or place of management (Sec. 1 (1) KStG). The unlimited tax liability must exist in each case at the end of the fiscal year of the intermediate company (cf. Sec. 7 (2) AStG).

Limited taxpayers:

The Controlled foreign corporation rules apply to a limited taxpayer if the participation in the foreign corporation is directly or indirectly attributable to a domestic permanent establishment of the taxpayer through which a commercial activity within the meaning of Sec. 15 (2) EStG is carried out.

Mastery:

The controlled foreign corporation rules further require that the taxpayer controls a foreign corporation (cf. Sec. 7 (2) to (4) AStG). This is the case if the taxpayer itself or together with related parties (within the meaning of Sec. 1 (2) AStG) at the end of the relevant financial year of the relevant foreign corporation directly or indirectly

• holds more than 50% of the voting rights or nominal capital, or
• is entitled to more than 50% of the profits or liquidation proceeds of the foreign company.

Related parties:

§ Sec. 7 (3) Sentence 2 AStG defines the term "related party" with reference to Sec. 1 (2) AStG. Related persons do not have to be subject to unlimited or limited tax liability in Germany, but may also be natural persons or legal entities resident abroad and subject to tax.

Intermediary companies may themselves qualify as related parties. Control may arise, for example, from the fact that the taxpayer controls the foreign intermediate company exclusively indirectly through one or more related parties.

Example:

• M-GmbH, which is subject to unlimited tax liability in Germany, holds 25% of the nominal capital of T-SARL, which is resident for tax purposes in Luxembourg. The remaining shares in T SARL are held by third parties who are not related parties of M-GmbH. T-SARL, in turn, holds 51% of the nominal capital of a limited company with its registered office and place of management in Cyprus ("Ltd."). The Ltd. is a low-taxed intermediate company that generates passive income.
• On a calculated basis, M-GmbH holds only 12.75% of the shares in the Ltd. and thus holds neither more than half of the voting rights nor more than half of the shares in the nominal capital of the Ltd. Control of the Ltd. by M-GmbH should be ruled out per se.
• However, the 51% shareholding of T-SARL in the Ltd. could be attributable to M-GmbH for the purposes of the control test because M-GmbH holds 25%, and thus at least one quarter, of the nominal capital of T SARL (cf. Sec. 1 (2) No. 1 (a) AStG in conjunction with Sec. 7 (3) Sentence 1 AStG) and T-SARL is therefore related to M-GmbH.
• The argument against this interpretation of the provision is that it leads to excessive results that no longer have anything to do with "control" of the intermediate company. It remains to be seen how the tax authorities will interpret the new provisions introduced by the Act Implementing the Anti-Tax Avoidance Directive in 2021.

Furthermore, persons are deemed to be related parties of the taxpayer if they cooperate with the taxpayer in relation to the intermediate company by means of concerted behavior. The explanatory memorandum to the Act Implementing the Anti-Tax Avoidance Directive cites, for example, the involvement of members of the same family as an example of interaction that is supposed to justify treatment as related parties. However, this does not apply in substance, because not every family relationship necessarily constitutes a related party and there may well be conflicting interests among family members. Accordingly, it is also not appropriate if - as stipulated in Sec. 7 (4) Sentence 2 AStG - such a relationship is rebuttably assumed for partners of a partnership or co-entrepreneurship that holds an interest in an intermediate company on the basis of the structure under company law.

Income from passive acquisition:

The provision of Sec. 8 (1) AStG defines active income that is not subject to the controlled foreign corporation rules. Conversely, passive income exists if it does not expressly fall under one of the active catalog activities of Sec. 8 (1) AStG.

Each individual activity of the intermediate company is to be examined on the basis of the activity catalog. Insofar as the income is derived from a passive activity, it is subject to the controlled foreign corporation rules, provided that the other conditions (in particular control and low taxation) are met.

Agriculture, forestry, manufacturing, energy production and extraction of mineral resources (Sec. 8 (1) and (2) AStG):

Income of foreign corporations from this group of income is active without exception and is not subject to the controlled foreign corporation rules.

Note: While income from the production of movable or immovable assets qualifies as an asset, this does not apply to the development of software, for example, because software is an intangible asset. The production of intangible assets will mostly be services within the meaning of Section 8 (1) no. 5 AStG.

insurance companies, credit institutions and financial services institutions (Sec. 8 (1) No. 3 AStG):

Income from insurance companies, credit institutions and financial services institutions is generally active. Exceptionally, income from passive activities is deemed to exist if more than one third of the foreign company's income is derived from transactions with the taxpayer or persons related to the taxpayer.

Note:Interest is always passive unless it can be functionally attributed to active income or it is covered by Sec. 8 (1) No. 3 AStG. This very restrictive treatment of interest income is of considerable practical relevance; outside of Sec. 8 (1) No. 3 AStG, interest can only be "active" if it is functionally related to an active activity.

trade and services (Sec. 8 (1) nos. 4 and 5 AStG):

Income from trade and from services is generally active. Income from trade, on the other hand, is considered passive insofar as the trade is conducted with the taxpayer or his related parties (purchase or sale of goods), unless the foreign company maintains a business operation set up in a commercial manner for the purpose of carrying out the activity, participating in general economic transactions, and the taxpayer proves this.

The income from services is exceptionally derived from passive acquisition to the extent that (i) the foreign intermediate company "uses" a shareholder or related party to provide the services or (ii) the services are provided to a domestic participant or related party. In the latter case, there is in turn a non-recurring exception if a business established in a commercial manner is maintained with participation in general economic transactions and the activities pertaining to the preparation, conclusion and execution of the transactions are carried out without the involvement of a domestic taxable person or a person closely associated with him.

Renting and leasing, licensing and transfer of use of movable property (Section 8 (1) No. 6):

Income from renting and leasing is in principle - and subject to far-reaching exceptions - not subject to the controlled foreign corporation rules. The first exception relates to the transfer of use of intangible assets (licensing) and is to be classified as a passive activity if the taxpayer does not prove that the foreign corporation exploits the results of its own research or development work undertaken without the involvement of a taxpayer who has an interest in the corporation pursuant to Section 7 AStG or a person closely associated with such a taxpayer (Section 8 (1) No. 6 (a) AStG). According to the second exception, income from the rental and leasing of real estate is added as income from passive activities, unless the income is exempt from German tax in the case of direct receipt under a DTA (Sec. 8 (1) No. 6 (a) AStG). Finally, as a third exception, income from the rental or leasing of movable property is also considered passive unless a business operation set up in a commercial manner is maintained with participation in general economic transactions and is carried out without the involvement of a taxable person in Germany or a person closely related to him (Sec. 8 (1) (c) AStG).

profit distributions (Sec. 8 (1) No. 7 AStG):

Profit distributions by corporations are, in principle, active income. Profit distributions qualify as passive income if they have reduced the income of the providing corporation (Sec. 8 (1) No. 7 (a) AStG). There are, in turn, two reverse exceptions to the above exception - in which case profit distributions again qualify as assets: (i) If the providing corporation is itself an intermediate corporation with the income underlying the profit distribution - in order to avoid double counting of profit distributions under the controlled foreign corporation rules (Sec. 8 para. 1 No. 7 letter a, aa AStG) and (ii) if the profit distribution as a so-called hidden profit distribution has increased the income of the intermediate company or a related party and this income is not subject to low taxation (Sec. 8 (1) No. 7 letter a, bb AStG).

According to a further exception, so-called free float dividends are passive if they would fulfill the requirements of Sec. 8b (4) KStG at the recipient's end, i.e. if the intermediate company's shareholding in the distributing corporation at the beginning of the calendar year directly amounted to less than 10% of the share capital or capital stock (Sec. 8 (1) No. 7 (b) AStG).

The last exception relates to dividends if they would be subject to taxation at the intermediate company due to Sec. 8b (7) KStG (exception for credit institutions and certain financial services companies) according to Sec. 8b (1) KStG (Sec. 8 (1) No. 7 letter c AStG): Such dividends qualify as passive income. 

Gains from the sale of shares in another company (Sec. 8 (1) No. 8 AStG):

Capital gains from shares in a corporation are always capitalized. Gains on the disposal of shares are exceptionally passive if the capital gains would not be tax-exempt at the foreign company pursuant to Sec. 8b (7) KStG (exception for credit institutions and certain financial services companies) if the latter were subject to unlimited corporate income tax.

conversions (Sec. 8 (1) No. 9 AStG):

Conversions are generally active. Exceptionally, this does not apply to the extent that the income derives from the transfer of assets which do not serve to generate active income within the meaning of Sec. 8 (1) No. 1 to 8 AStG. There is, in turn, a reverse exception to this - in which the income from a conversion qualifies as active if the taxpayer proves that (i) the conversion could have taken place in Germany at book values - notwithstanding Sec. 1 (2) and (4) UmwStG - and (ii) it actually took place abroad at book values.

§ Sec. 8 (2) AStG provides for an "escape" from the controlled foreign corporation rules if the taxpayer proves for a foreign intermediate company in an EU/EEA state that the participation in the company is not based on an artificial arrangement (exoneration evidence). This is the case if an EU or EEA corporation carries out a substantial economic activity in its state of residence by using the necessary material and personnel resources through sufficiently qualified personnel acting independently and on their own responsibility, without outsourcing this activity predominantly to third parties. The proof of exoneration is excluded in so-called third country cases, i.e. if the foreign company has neither its registered office nor its management in an EU or EEA state (Sec. 8 (3) AStG). Furthermore, the proof of exoneration does not apply if the state in which the foreign company is domiciled does not provide any information by way of intergovernmental exchange of information that is required to carry out the taxation (Sec. 8 (4) AStG).

If the proof of exoneration is successful, the company does not qualify as an intermediate company and does not fall under the provisions of the controlled foreign corporation rules. There are serious doubts as to whether the high requirements for the substance test are compatible with Community law and applicable BFH case law.

In terms of procedural law, it should be noted that the assertion of the proof of exoneration pursuant to Section 8 (2) must be notified by the taxpayer using an officially prescribed form.

A country qualifies as a "tax haven" if the income determined in accordance with German tax law for which the foreign company is an intermediate is subject to an income tax burden of less than 25% without this being based on an offset with income from other sources (cf. Sec. 8 (5) Sentence 1 AStG). A reduction of the low taxation threshold to the level of the German corporate income tax rate, currently at 15%, is long overdue.

Moreover, the low tax threshold of 25% may lead to a penalty taxation of passive income of a foreign intermediate company: If an addition amount, which has already been subject to a tax of more than 15% but less than 25% abroad, is added to a domestic corporation, a full credit may be given for corporate income tax, but, as is well known, not for trade tax. Such credit overhangs - which regularly arise at tax rates between 15% and 24.99% - cannot be justified by the fact that a further purpose of the controlled foreign corporation rules is to ensure an appropriate pre-taxation of profits at the level of the foreign corporation. 

The provision of Section 9 AStG contains an exception to the controlled foreign corporation rules if the foreign corporation generates both active and passive income and the following conditions are met cumulatively:

• The foreign corporation's gross passive income does not exceed 10% of the corporation's total gross income (relative corporate exemption limit).
• The gross passive income of the company may not exceed a total amount of EUR 80,000 (absolute company-related exemption limit).
• Finally, with respect to the level of the shareholder liable to tax in Germany, the gross passive income, taking into account all of his participations, may not exceed the amount of EUR 80,000 (absolute shareholder-related exemption limit).

Due to the low exemption limits, the provision is not of great practical significance. Exceeding the exemption limits - even if only to a small extent - means that the exemption does not apply.

What are the legal consequences of the controlled foreign corporation rules?

If the requirements of the controlled foreign corporation rules are met, the income for which the foreign company is an intermediate company is taxable for the unlimited - or, if applicable, limited - taxpayer in proportion to its direct and indirect participation in the nominal capital. This results from Sec. 7 (1) Sentence 1 AStG and is specified in Sec. 10 (1) Sentence 1 AStG (addition amount). The additional amount is deemed to have accrued in the assessment period in which the relevant financial year of the foreign company ends (Sec. 10 (2) AStG).

If the taxpayer holds the participation in the foreign intermediate company as private assets, the addition amount is income from capital assets within the meaning of Sec. 20 (1) No. 1 EStG. However, if the participation is part of the taxpayer's business assets, the addition amount is part of the income from trade or business, from agriculture and forestry or from self-employment.

The so-called partial income procedure pursuant to Sec. 3 No. 40 Sentence 1 Letter d and Sec. 32d EStG, as well as the tax exemption pursuant to Sec. 8b (1) KStG do not apply to the income from the additional amount. Furthermore, Sec. 9 No. 7 GewStG is expressly not applicable. This results in a definitive taxation of the income from the additional amount. In the case of private assets, the additional amount is subject to the standard income tax and the solidarity surcharge as income from capital assets. In the case of business assets, the additional amount is subject to the standard income tax or corporation tax and the solidarity surcharge. The additional amount is subject to trade tax if it is included in income from trade or business.

If the requirements of the controlled foreign corporation rules are met, the income for which the foreign company is an intermediate company is taxable for the unlimited - or, if applicable, limited - taxpayer in proportion to its direct and indirect participation in the nominal capital. This results from Sec. 7 (1) Sentence 1 AStG and is specified in Sec. 10 (1) Sentence 1 AStG (addition amount). The additional amount is deemed to have accrued in the assessment period in which the relevant financial year of the foreign company ends (Sec. 10 (2) AStG).

If the taxpayer holds the participation in the foreign intermediate company as private assets, the addition amount is income from capital assets within the meaning of Sec. 20 (1) No. 1 EStG. However, if the participation is part of the taxpayer's business assets, the addition amount is part of the income from trade or business, from agriculture and forestry or from self-employment.

The so-called partial income procedure pursuant to Sec. 3 No. 40 Sentence 1 Letter d and Sec. 32d EStG, as well as the tax exemption pursuant to Sec. 8b (1) KStG do not apply to the income from the additional amount. Furthermore, Sec. 9 No. 7 GewStG is expressly not applicable. This results in a definitive taxation of the income from the additional amount. In the case of private assets, the additional amount is subject to the standard income tax and the solidarity surcharge as income from capital assets. In the case of business assets, the additional amount is subject to the standard income tax or corporation tax and the solidarity surcharge. The additional amount is subject to trade tax if it is included in income from trade or business.

Section 13 of the German Income Tax Act governs the controlled foreign corporation rules for income of an investment nature, which also applies if the criterion of control of the foreign company is not met. In principle, the controlled foreign corporation rules apply in the case of a shareholding of at least 1% in an investment company. If the investment company generates exclusively or almost exclusively (more than 90%) income of an investment nature, the controlled foreign corporation rules apply without any minimum shareholding, provided that there is no substantial and regular trading in the main class of shares of the foreign company on a recognized stock exchange (stock exchange clause). Section 13 AStG is narrower in scope than the controlled foreign corporation rules under Sections 7 to 12 AStG: The provision only applies to unrestricted taxpayers and requires purely corporate "interests" in the investment company.

Income of an investment nature is low-taxed income (including capital gains) "derived from holding, managing, preserving or increasing the value of cash, receivables, securities, participations (excluding income as defined in section 8(1)(7) and (8)) or similar assets". This also includes, among other things, income from finance leases, insofar as it is not a rental activity, factoring, financial innovations and forward transactions. Income of an investment nature also includes corresponding capital gains and losses, as well as ancillary income functionally attributable to income of an investment nature, for example from hedging transactions. Income of an investment nature is thus primarily interest, but not profit distributions and gains on the sale of shares.

Income of an investment nature does not exist if the taxpayer proves that the income is derived from an activity that serves an own activity of the foreign company within the meaning of Sec. 8 (1) nos. 1 to 6 AStG (Sec. 13 (2) half-sentence 2 AStG).

The proof of exoneration by means of a substance test pursuant to Sec. 8 (2) and (5) AStG applies accordingly to the foreign investment company. Due to the lack of a reference in Sec. 13 (4) AStG to Sec. 8 (3) AStG, the possibility of providing evidence of exoneration also exists for cases involving third countries. Cases without intergovernmental exchange of information are excluded from the proof of exoneration (Sec. 13 (4) Sentence 2 AStG).

Foreign investment funds in statutory form (e.g. a Luxembourg or French SICAV) and so-called foreign special investment funds may qualify as foreign intermediary companies within the meaning of Section 7 (1) AStG and fall under the controlled foreign corporation rules.

In principle, however, the investment taxation rules take precedence over the controlled foreign corporation rules: Pursuant to Sec. 7 (5) Sentence 1 AStG, for investment funds (including special investment funds) and their investors, taxation under the Investment Tax Act (InvStG) takes precedence over the Controlled foreign corporation rules. Therefore, within the scope of application of the InvStG, the provisions of Sections 7 et seq. AStG do not apply in principle.

With regard to the taxation of domestic and foreign investment funds, they are treated equally under the InvStG 2018. However, a distinction must be made between investment funds and special investment funds:

• Under the InvStG 2018, investment funds are subject to a taxation regime based on the principle of segregation. Accordingly, investors in an investment fund who are subject to tax in Germany must pay tax on the annual income from investment funds (distributions and capital gains) and - if the distributions of an investment fund within a calendar year fall short of the basic income for that calendar year - an advance flat rate of 70% of the redemption price determined at the beginning of the calendar year in accordance with section 203(2) of the BewG.
• For so-called special investment funds, on the other hand, the principle of taxing so-called distribution-equivalent income will be continued beyond January 1, 2018. Distribution-equivalent income is the positive income of a special investment fund specified in section 36(1) sentence 1 of the InvStG that is not used for distribution within four months of the end of the fund's financial year (section 36(6) of the InvStG). In this context, the income equivalent to distributions only corresponds to a portion of the income generated by the special investment fund during the fiscal year. The income not included in the distribution-equivalent income is therefore not taxable in the case of reinvestment and is only subject to taxation for the investor upon distribution or sale of the special investment fund units.

Both the advance lump sum and the taxation of income equivalent to distributions are groups of cases of upstream taxation prior to distribution. Similar to the Controlled foreign corporation rules, retained income of the investment fund is taxed at the investor level. The legislator has therefore resolved the competition between investment and controlled foreign corporation rules by giving investment taxation priority in principle.

However, the priority of investment taxation pursuant to Sec. 7 (5) Sentence 1 AStG only applies if the foreign investment fund itself directly receives the passive income. This is not the case if the foreign investment fund itself holds interests in other foreign intermediate companies and these lead to an indirect controlling interest for the domestic investor. In this case, the passive income of the indirectly held foreign intermediate company is added directly (bypassing the investment fund). The investment fund therefore no longer shields itself from intermediate income of indirect holdings whose income is not subject to the InvStG.

Moreover, the priority of investment taxation does not apply "if more than one-third of the transactions underlying the income are conducted with the taxpayer or persons closely related to the taxpayer." In practice, it will probably not be common for the controlling investor to conduct business with the (special) investment fund. Moreover, in the case of mutual investment funds, the control requirements will usually be lacking. In the case of institutional investors and family offices as investors in an investment fund, however, control is just as conceivable as in the case of group-owned contractual trust arrangements or private equity funds. If, for example, a foreign (special) investment fund conducts business with persons related to the investor (e.g. granting shareholder loans and the resulting passive interest income) and the passive income from this amounts to more than 1/3 of the income of the investment fund, the priority of investment tax law does not apply to the investor on the basis of Sec. 7 (5) Sentence 2 AStG. The passive income of the (foreign) investment fund is then subject to the controlled foreign corporation rules for the investor, so that the Foreign Tax Act and the InvStG are applied simultaneously. In order to avoid the resulting double taxation, Section 10 (6) AStG provides for a reduction of the addition amount.

On closer examination, however, there are good arguments that, for example, passive interest income of a foreign investment fund that is also a foreign intermediate company should not be subject to low taxation:

• According to Secs. 8 (5) Sentence 1 and 10 (3) Sentence 1 of the German Income Tax Act (AStG), the "income on which the addition amount is based [...] must be determined by applying the provisions of German tax law mutatis mutandis" in order to determine the low taxation.
• The regulations of the InvStG are part of German tax law.
• Therefore, the tax exemption (Sec. 6 (2) InvStG) must be taken into account in the "low taxation" test.
• As a general rule, (domestic and foreign) investment funds can collect tax-free interest that is independent of profits and unsecured.
• If the tax exemption pursuant to Sec. 6 (2) InvStG is to be taken into account when examining whether the interest is "low-taxed", the controlled foreign corporation rules cannot apply because there is no "low-taxation" for non-profit and unsecured interest.
• The question of whether the investment taxation rules take precedence over and exclude the controlled foreign corporation rules then does not arise.

In the case of participations in (foreign) investment funds, investors subject to unlimited tax liability may also hold participations in investment companies within the meaning of Section 13 AStG as addition addressees. In this case, controlled foreign corporation rules would apply even without a minimum shareholding of more than 50% (cf
. Sec. 13 (1) Sentence 1 AStG):

• An investment company is a company that generates income of an investment nature. This is income (including capital gains) derived from holding, managing, preserving or increasing the value of cash, securities, investments or similar assets (Sec. 13 (2) AStG). Income of an investment nature is thus primarily interest, but not profit distributions and gains on the sale of shares.
• If the investment company generates exclusively or almost exclusively (more than 90%) income of an investment nature, a minimum shareholding is not relevant, so that even the smallest shareholdings can lead to the controlled foreign corporation rules. In addition, the controlled foreign corporation rules apply to a shareholding of at least 1%.
• For investment companies, however, Sec. 13 (5) Sentence 1 AStG stipulates that the InvStG takes precedence if their income is subject to the provisions of the InvStG and the investor with unlimited tax liability holds a direct interest in the (special) investment fund.
• Indirect shareholdings of the (foreign) investment fund in investment companies are also irrelevant if the investor liable to tax in Germany holds them indirectly via a (special) investment fund (Sec. 13 (5) Sentence 2 AStG).
• The InvStG therefore not only has a "blocking effect" with regard to income generated directly by (special) investment funds in relation to the controlled foreign corporation rules, but also in the case of indirect participation via a foreign as well as a domestic (special) investment fund.
• In the case of investment companies and income with investment character, the blocking effect of the InvStG thus goes considerably further than in the case of foreign intermediate companies with "ordinary" passive income.

The provision of Sec. 20 (2) AStG applies if passive interim income of a foreign permanent establishment of an unlimited taxpayer would have to be exempted from taxation on the basis of a double taxation agreement (DTA). Double taxation of such income is then to be avoided not by exemption but by crediting the foreign taxes levied on such income.

The so-called switch-over clause of Sec. 20 (2) AStG implies a hypothetical view/fiction: Instead of the foreign permanent establishment, a foreign company within the meaning of Sec. 7 (1) Sentence 1 is to be fictitiously established and it is to be examined whether the income would be taxable as interim income. This presupposes the existence of the other requirements of the controlled foreign corporation rules according to Secs. 7-13 AStG. Only the so-called substance test of Sec. 8 (2) AStG does not apply in the context of Sec. 20 (2) AStG. Control of the deemed foreign company is regularly given in the case of a foreign permanent establishment of an unlimited taxpayer. The situation is different in the case of a permanent establishment of a domestic or foreign partnership: The predominant opinion in the literature is based on whether the unlimited taxpayer controls the partnership, whereas according to the tax authorities, the extent of the participation in the partnership is not relevant in this respect.

The legal consequence of Sec. 20 (2) AStG is that the passive income is not exempt. Instead, double taxation is avoided by tax credit in accordance with Section 34c (1) EStG and Section 26 (1) and (6) KStG. It should be noted that the low-taxed passive income of a foreign permanent establishment/partnership is covered by the fiction of Sec. 7 Sentence 8 GewStG and is deemed to have been generated in a domestic permanent establishment. Thus, the passive income is in principle also subject to trade tax if the unrestricted taxpayer to whom the addition amount would be attributable is engaged in commercial activities and maintains a domestic permanent establishment.

Sections 16, 17 AStG concern the taxpayer's duty to cooperate. In particular,
Sec. 17 AStG, which specifies the extended duty to cooperate in foreign matters, relates
 to the controlled foreign corporation rules. According to Sec. 17 (1) AStG, taxpayers must provide the necessary information. The shareholder concerned is thus obliged to provide information, for example, with regard to the legally relevant activity characteristics pursuant to Sec. 8 AStG. Moreover, Sec. 17 (2) AStG provides an estimation framework for the income of intermediate companies that is subject to addition. 

The taxation bases for the application of the controlled foreign corporation rules according to Secs. 7 - 13 AStG, in particular the addition amount (Sec. 10 AStG), the creditable taxes (Sec. 12 AStG), the so-called addition adjustment volume (Sec. 12 AStG) and, if applicable, a loss carryforward are determined separately. If several recipients of the addition are involved in an intermediate company, the separate determination is made uniformly for all of them.

Every taxpayer with a direct or indirect holding in a foreign intermediate company must submit a declaration of assessment in accordance with an officially prescribed form (Sec. 18 (3) Sentence 1 AStG). If the taxpayer invokes the proof of substance pursuant to Sec. 8 (2) AStG, this must be reported on an official form (Sec. 18 (3) Sentence 2 AStG).